FedNow: instant payments or instant fraud?

The title industry discusses the pros and cons of the Federal Reserve’s new payment rail

Being able to close on a home at any time on any day of the year has long been a pipe dream, but the Federal Reserve’s new FedNow instant payment system looks to be making that dream a reality. However, before one gets too excited, the title insurance industry is asking if it really is worth sacrificing security for speed.

“There is the obvious perceived benefit of faster payment and they are touting that it will be cheaper than wire transfers, and of course you no longer have to worry about missing the 5pm cut off,” Tyler Adams, the CEO of CertifID, said. “But I can’t help but think that this is going to be absolute rocket fuel for fraud because you are going to end up with irrevocable payments. They can’t get the money back.”

As of now, FedNow is set to launch in July of this year. The platform will be available to financial institutions of every size throughout the United States, enabling users to send and receive payments  up to $500,000 24 hours a day, 365 days a year. FedNow says the platform will be flexible and will be able to be used by a variety of financial institutions and with aggregators, processors, and correspondents.

Individuals whose banks or credit unions sign up for the FedNow payment platform will be able to send and receive requests for payment through their credit union or bank’s mobile application.

If a homebuyer uses the FedNow payment service in their closing process, the homebuyer will receive a request for their down payment from their title company. The homebuyer then sends the funds through FedNow and the bank reviews the payment and sends an ISO 20022 compliant payment message to the FedNow payment service, which immediately validates the payment and passes it along to the title firm’s bank which tells FedNow it intends to accept the payment and FedNow debits and credits the respective banks.

The funds settle between the banks in real time and users will have immediate access to the newly transferred funds.

But while the convenience is tantalizing for an industry looking for ways to streamline and speed up the home buying process, title industry professionals, who have been working to battle the increasingly menacing threat of wire fraud, see some major risks.

In 2022 alone, Adams’ firm CertifID identified $1.4 billion in suspected wire fraud attempts. According to the company, this represents a 145% year over year increase in instances of reported wire fraud. In addition, 83% of CertifID’s customers had at least one wire fraud experience in 2022.

While 2022’s dramatic uptick in fraud certainly caught Adams attention, what was more concerning was the pace at which money was moving.

“Money is moving faster,” Adams said. “Already in the first quarter of this year we have had less success with some recoveries that used to, like two years ago, be no-brainers and we’d get all their funds back. But now they are just so well orchestrated – money is hitting the money mules’ accounts and they are pulling it out within an hour. It is just terrifying how fast things are moving now.”

With FedNow’s capacity for instant payments the level of concern about fund recovery has skyrocketed in the title space.

“If you do have a successful wire fraud attempt, the one thing we have going for us right now is that wires can be recalled,” Bill Burding, the executive vice president and general counsel for Orange Coast Title, said. “Typically if we catch wire fraud it is within the first 24 hours, we have a good chance at fixing it, but with this system you really can’t fix it because once that money has gone into the system it is gone forever. Once it gets from one account to the other, then you can transfer right out of the country to an international bank account and it is gone.”

Adams also expressed concern about fraudsters’ ability to make requests for funds look even more convincing through a bank or credit union’s mobile application.

“They could in fact make it look more trustworthy, which is scary,” Adams said. “Imagine if they set up a bank account that looks similar to your title company and now you get a request inside your portal and it says this title company wants money, who is not going to click on that. With an email for wiring instructions it might look funny or there might be a misspelling and you at least have a chance of catching it.”

Although it is enthusiastic about the platform, even FedNow itself is warning users about the potential risks.

“You can’t avoid it – the potential for fraud exists with any type of payment process, and that includes instant payments. As instant payments become more popular around the world, fraud will continue to be a threat,” a post on the Federal Reserve services website reads.

The webpage instructs users to consider the speed, finality and always on nature of instant payments when considering whether or not to use them and evaluating the risks involved.

“Clearing and settlement occurs almost immediately, minimizing the time frame to detect fraud and stop fraudulent payments from processing,” the page reads. “Immediate settlement equates to immediate irrevocability, with funds available for the payee to withdraw. Instant payments operate on a 24x7x365 basis, giving fraudsters the opportunity to attack at any time. That means that fraud detection must occur continuously, with processes or controls in place to act quickly.”

According to FedNow’s “Fraud at a glance” pamphlet, the platform will have a “return request” option, allowing financial institutions to submit a message requesting another FedNow participant return the amount of a transaction identified as fraudulent. Despite this precaution industry participants are asking individuals and financial institutions to examine their risk appetite before using FedNow.

“Organizations need to look at fraud related to instant payments differently,” Mike Timoney, vice president for secure payments with the Federal Reserve Bank of Boston, said in a statement on FedNow’s website. “You can’t assume that everything is going to be the same. The nature of instant payments needs to be taken into consideration, and organizations need to be prepared for it. It’s important to get the fraud people involved in plans early. It doesn’t mean you have to build a best-in-class fraud system before you can launch instant payments, but your team can advise on a phased approach for enhancing your defenses that protect you even when initial volumes are low. Organizations need to be cognizant of their vulnerabilities; the worst thing they can do is nothing. What organizations need is a well-considered plan.”

In order to improve security, FedNow said it will be using multi-factor authentication and that all connectivity to the FedNow service will be mutually authenticated. However, as fraudsters have proven, once they have infiltrated a transaction they can easily authenticate fake identities using fraudulent email addresses and phone numbers.

If fraud does occur, FedNow said it is requiring participants to report it to the FedNow Service.

“This information will be used to strengthen the FedNow network and support counterparty fraud mitigation processes,” FedNow’s “Fraud at a glance” pamphlet reads.

While FedNow would not confirm this, based on the language used on its website and in its fraud prevention pamphlets, the onus of preventing fraud from occurring appears to be on transaction participants, namely customers and title companies, with prevention tips including: “enlist you customers in prevention,” “Talk with your vendors about tools to improve detection,” and “review and upgrade your systems as needed.”

“If you look at the way that banks have been able to skirt really any liability for wire fraud, they have the precedent to do the same for these instant payments,” Adams said. “But that is a lot of responsibility to then place on the consumer. And now if money can’t be recalled, that is going to put even more pressure on the companies that we support.”

From a title company’s perspective this assertion is spot on.

“In a perfect world, if it works it is gorgeous,” Aaron Davis, the CEO of Florida Agency Network, said. “We typically have up to three payments coming into a transaction: there is one ACH and/or check and then two wires. Then outbound, on a standard purchase file there are about 15 payees and some will want an ACH and some will want a check and some will want a wire, so if you are telling me that you can get all of it done in an instantaneous transaction, it is fantastic, but we don’t really know what it will look like yet and we don’t know how we will be able to keep track on the workflows with it and make sure funds get to the right place.”

The initial product release in July will provide baseline functionality that will support market needs such as account-to-account transfers (A2A) and bill pay. However, FedNow expects additional features to be launched as the need for them arises.

“Ultimately, the number one thing we have here is that this system is not built for us and it needs to be modified in the banks that are willing to do it,” Burding said. “Without the proper examination of the issues and making sure that we do prevent wire fraud, as much as the speed is really wonderful, the chances for loss turn out to be greater.”

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